Effect of currency exchange rates / depreciating rupee on Real Estate

Today, rupee reached a fresh record low of 65.5, falling almost 23% in past four months or say almost 45% in last 2 years. This makes me think that people who have bought properties or planning to buy one in the near future would surely want to know its effect on real estate. Is this the right time to spend all those life savings into buying property. If yes, then which location would make more sense right now? Let us understand what has happened to rupee and how it affects the real estate market. But before, it is quite interesting to know rupee more closely.  

History of Rupee

It was only the day we got independence that Indian rupee could match the dollar value, when $1 was equal to Re. 1. At that time, rupee was linked to pound and the country had no external borrowings.

With the introduction of first Five Year Plan, government borrowed from outside and as a result we see Maharatnas such as SAIL etc. (Though when we look in hindsight, it’s hard to find any recent industries of such scale set up by the government. Anyways, that’s another discussion all together. )

Post-independence, India followed a fixed rate regime between till year 1966 when $1 = Rs. 4.79. The two wars with China and Pakistan in year 1962 and 1965 resulted in huge budget deficit. The government was forced to devalue Indian currency and $1 = Rs. 7.57. In 1971, government linked rupee to dollar.

1973	7.66	1983	10.11	1993	31.26	2003	46.60
1974	8.03	1984	11.36	1994	31.39	2004	45.28
1975	8.41	1985	12.34	1995	32.43	2005	44.01
1976	8.97	1986	12.60	1996	35.52	2006	45.17
1977	8.77	1987	12.95	1997	36.36	2007	41.20
1978	8.20	1988	13.91	1998	41.33	2008	43.41
1979	8.16	1989	16.21	1999	43.12	2009	48.32
1980	7.89	1990	17.50	2000	45.00	2010	45.65
1981	8.68	1991	22.72	2001	47.23	2011	46.61
1982	9.48	1992	28.14	2002	48.62	2012	53.34

                                Table: Average annual exchange rates of India from 1973 to 2012

Then comes 1991, when India suffered low growth and high inflation. Even forex reserves had dwindled to such an extent that the country couldn’t afford three weeks of imports. As a result, rupee was devalued to 17.90 against a dollar.

In 1993, government switched to a free-floating currency. The exchange rate would now be determined by the market based on supply and demand. In a free-floating currency, government intervenes only when it feels the dire need to control the volatility. High volatility in the currency rate can prove detrimental to a country. Rupee got devalued to 31.37 against a dollar.

Average annual exchange rates - USD/INR

Major factors that affect currency exchange rates?

High inflation: Every developing economy withstands high inflation. Reason being that a developing economy is one where large investments are made that leads to high growth rate. Large investments lead to large inflow of money in the economy thereby increasing the money supply. And we know that increased money supply will lead to increase in demand, thereby causing inflation. If the purchasing power parity has to hold good, the rupee has to adjust to the change in inflation against dollar. Let us take an example to explain this purchasing power theory and inflation. Let say the price of 1 kg rice on India is Rs. 50. The same is available in U.S. for $1. Inflation in India is 10% whereas in U.S. it is 2% per annum. So after a year, the rice would cost Rs. 55 in India and $1.02 in U.S. As a result the new exchange rate would be 55/1.02 = 53.92. During high inflation, depreciation of currency is quite natural.

High Trade deficit: Trade deficit is another reason contributing to rupee depreciation. High current account deficit wherein imports are greater than exports leading to trade deficit for India leads to increasing demand for dollar for imports. As demand for dollar rises, its value appreciates and the rupee depreciates.

Useful read: Association between current account deficit and Real estate market

FDIs and FIIs: These are the medium through which dollar flows into the Indian economy. As FDIs and FIIs decreases, the value of Indian currency depreciates. As you can see in the graph above, Rupee has appreciated in the period between 2002 and 2007 primarily because of this reason.   

Effect of exchange rate on Indian real estate

When rupee depreciates, it is likely to increase Real estate demands amongst the NRIs. This would lead to increase in demand by the NRIs which should lead to rise in prices. but there are other factors too. 

Useful read: NRI Real Estate investors benefit from Rupee depreciation

In the short run, this depreciating rupee will not affect the real estate prices in India. But a sustained depreciation of rupee will eventually lead to prices becoming dearer for buyers. Reason being that Indian economy is more import based with a trade deficit. As a result of rupee depreciation, Indians will have to pay out more for imported goods thereby decreasing there disposable income and making houses less affordable. Also, when inflation rises, central bank (RBI) increase the interest rates and tighten the economy thereby making home loans dearer. This will lead to decrease in demand by local buyers thereby putting a pressure on Real estate developers to reduce prices. On the other hand, inflation in construction material costs will lead to rise in construction costs. Thus, companies will turn out to be major losers in this scenario of increasing depreciation. 

History teaches us the best. When Argentina converted its fixed currency regime to a floating currency regime, its value depreciated by as much as 66% in a few months compared to dollar. But Real estate prices in superior locations did not fall that much. Scarcity of financing did not hinder the market as much as anticipated. A substantial change in the profile of buyers occurred, from home-owners to non-resident Investors. If one measured the market in pesos (the Argentine currency) it generally went up and devaluation benefited the real estate market—if measured in foreign currency (assets in euros or dollars)—depreciated, but not in proportion to the Argentine currency devaluation. ( Devaluation and Real Estate values: The Argentine case by ARQ. JOSÉ R. ROZADOS, ARQ. GERMÁN GÓMEZ PICASSO, AND RICARDO ULIVI, PH.D.)     

Advice for home buyers

One can buy homes in IT hubs or rather export hubs of the country. Bangalore, Pune and Hyderabad make sense to me personally. Or else, the best and riskless strategy for investors is to wait and watch till the currency becomes less volatile. But then we know that there is “no risk, no gain”. J

Any further interpretation of effects of exchange rate on real estate market is most welcome. 
Would request you to enter your email address in the right side bar of this page under "follow by email" to get a regular update of my articles. "Knowledge is the food for the brain"  

Correlation between current account deficits and Real estate prices

Let’s understand the Current account from the perspective of an economy first. Current Account is a part of Balance of Payment for a country, the other part being the Capital Account.

Factors of Current Account for an economy

As we can see from the chart above, Imports and exports form a major part of current account of a country. If import is more than the export of a country, it leads to a current account deficit for the country which is the case in a country like India.  

Imports for India in 2011-12:               $ 485 bn

Exports for India in 2011-12:               $ 300 bn

Oil and Gold imports are two major contributors of rising current account deficit in India. India spent a staggering $ 160 billion to import crude oil in 2011-12, an amount equivalent to more than half of the country's total earnings from exports during the same period. Gold is the second major import item for India after petroleum and constituted 11.3 per cent of total imports in 2011-12 in value terms. A current account deficit in excess of 2.5% of GDP is seen as worrisome in case of India. (Source: Bureau of Economic Analysis)

But why write this article on effect of CAD on housing prices? The rationale to emphasize on current account deficit is the dependence of Indian economy on large foreign capital inflows.

House price changes depend on certain macro-economic factors such as GDP per capita, inflation, mortgage rates as well as current account deficits of the country.

HP = c + β₁ GDPC + β₂ INF + β₃ MR + β₄ CAD + €

Where,

GDPC = Gross Domestic Product of India per capita

INF = Inflation %

MR = Mortgage rate (% per year)

CAD = Current Account Deficit/GDP (%)

€ = error

All I am trying to say is that changes in house price would depend on certain macro-economic factors as mentioned above. As we can see, current account deficit is one of those factors. Literature published on effects of CAD on House price changes states that CAD has a positive effect on the house price changes. At first look it seems that increasing real estate prices is good for a country with significant current account deficits. This is because lenders feel comfortable in providing credits on seeing the increasing valuation of the property.

But then, there is a threshold point beyond which lenders start feeling uncomfortable about the economy as a whole and quality of collaterals in particular. I assume this is what happened during the sub-prime mortgage crisis in U.S. Moreover, increasing valuation makes people wealthier, leading to increasing purchases which in turn leads to increase in imports. When people start investing in houses, prices of which are rising, more and more money gets relocated to the construction sector thereby reducing investments in manufacturing sector, thereby reducing exports and increasing imports of construction material. This increases CAD even further.

Capital inflows should help reduce the CAD instead of aggravating it further. If such inflows are invested in real estate, it will only increase the prices further. I think an in depth research should be conducted in this field by real estate companies to understand the effects of CAD and realize the future of real estate in the coming months. Because ever increasing CAD in India currently can actually prove devastating. FDIs are surely considered a boon for an economy, especially one where the economy is suffering from CAD. Such inflows are welfare improving. But in the absence of proper rules and regulations, it can also prove to be a bane for the economy.     

Effect of rising inflation on Real Estate

My own recipe for world peace is a bit of land for everyone - Gladys Taber

Inflation is the prime concern of one-and-all right now, the sky touching prices of onion on one hand and future of property prices on the other. 

People feel that during any inflation, there is a price increase for all real assets such as commodities, plants and machinery as well as real estate. Whereas the opposite holds true for financial assets such as stocks and bonds. Even the explanation on correlation between inflation and real estate prices in http://www.investopedia.com/ask/answers/correlation-inflation-houses.asp states that inflation causes real estate prices to increase. Well the above statement is false as far as effect of inflation on real estate prices is concerned.

The reasoning that goes behind saying that real estate prices should rise during inflation is simple: the cost of construction material rises leading to rise in construction cost and increased money supply (cause for inflation) leading to rise in demands for house in the market.

Let us look at the reasoning for falsifying the above statement and claiming that real estate prices fall during inflation. The immediate effect of inflation in the market is on credits. Due to inflation, interest rates rise. And how do increased interest rates affect the house prices?

Housing is almost entirely driven by credits. Imagine what the situation would be when credit is completely eliminated from the market and people have to pay through cash for their house purchase. Housing prices would drop drastically. Banks that lends money, on seeing the inflation rate rise, will naturally react by increasing the interest rate on the credit outflows. Due to this increased interest rates, buyers will have to shell out more in form of EMIs. Whereas their salaries do not rise by the same amount. As a result, they tend to curtail borrowing. Real estate companies want banks to lend money at cheaper rates to be able to sell their properties. When this does not happen, real estate companies are forced to lower their prices. They cannot increase the prices of their properties at the same pace as inflation, because if they do, there won’t be buyers for their properties.

And you know who is the king at these times of high inflation, a person who has cash. This is the time of distressed sale when sellers want to sell their property due to personal needs and banks are not ready to provide easy mortgage. Then someone who has cash available with him tends to benefit the most. So, as inflation rises and property prices fall the next time, ensure that you sell the commodities that you own and buy real estate at reduced prices. Happy Investing! 

Why should Real Estate Companies provide Property Management Services

This is about the real estate companies that are looking towards Property management services as a strategic move to add to their topline and the bottomline of their companies. This contribution might seem low when seen in numbers, but the effect that this service would have on the company’s brand value and customers’ confidence is unparalleled.

Let us look at some of the major functions of Property Management Services:

• Maintenance and management of all amenities, security
• Facility management
• Administration and risk management
• Ensuring tenant and occupancy

Why it makes sense for real estate companies to provide property management services to their customers? Prestige Estates is one such real estate company that has over 2100 employees dedicated to deliver a high standard of service to property owners. There are clear benefits of providing these services to their customers as stated by the company. It helps the company in enhancing the longevity and resale value of the property, thereby gaining customers’ confidence. We buy property either for self-occupancy or to rent-out the same. Whatever be the reason, a house is a major investment for one-and-all. We as buyers expect that our property is well taken care of and kept in a good condition. This in turn increases the longevity as well as the resale value of the flat. What else we as buyers want, more so if our property is maintained by a reputed firm such as Prestige.

Useful Read: Should I invest in Real Estate or Stock Market

The company’s responsibility includes maintenance and management of all amenities, security, landscaping, gardening and offering rental and resale services to its clients. The company manages almost 80% of its residential and commercial properties developed. This life-cycle approach protects property aesthetics and strengthens property appreciation well after the property has been handed over.

Sub-leasing and fit-out services: The Company also sells properties to investors and arranges for the onward lease of these properties.  Besides, the company provides interior solutions and fit-outs following which it sub-leases the property to users. The company generates revenues by charging fees for fit-outs and profits from the difference in lease rentals given to investors and taken from investors.

In addition, Prestige Estates also provides Interior solution services and Mall management services.

Well there is no denying the fact that management of a property is more difficult than acquiring a property. It is more in the case of NRIs having properties in various parts of India. What better than a renowned real estate company taking responsibility for providing management services. This enhances the confidence of a customer in your brand thereby affecting your sales for the good.  

   

Resale flat or under construction flat

"It is a comfortable feeling to know that you stand on your own ground" - Anthony Trollope

Whenever we want to buy a property we always have two options with us, whether to buy a resale property from a previous customer or an under construction property directly from the builder.

Let us look at the advantages of a ready property. One gets immediate possession. As a result, the buyer either moves in into the new flat and escapes paying rent or else he earns rental yield on the property if he prefers to stay in his previous location. The buyer also avoids the risk of fraud from the developer’s side which is prevalent in the Indian market. This can be either in the form of specifications not being according to what was promised or else there is a delay in completion of the project. The buyer also enjoys tax deduction on the home loan from the beginning.

If a property on resale is old, considering other parameters of the house being same, it should sell at a lower rate than an under construction house. Wherever the land price is high and accounts for major cost of the property, the difference in the resale price and an under construction price is less. But in cases where builder launches at a discount to offload major part of his inventory, such properties will sell cheaper than the builder’s price. Reason being that the investors have already made a profit that they intended to in the first place. Moreover, taking possession would require extra cash outflow in form of registration and stamp duty. These are the people whose intention is just to earn profits and sell it and move to other launch which will give them higher returns. These sellers attract buyers by quoting a lower price than the builders.

When construction is at the stage of completion, generally the prices of builder’s inventory and those in the resale market tend to merge. The difference is more in the initial stage but in this case even the risk is higher.   

Useful Read: Which city to invest in Indian Real Estate

But there are circumstances when the price of ready possession will be higher than under construction. This generally happens in mature markets. The builder has sold all his property during launch. Now if a buyer wants to buy a flat in this locality, maybe because his office is nearby from this location or his kids study in a nearby school, he has no option but to buy from the resale market. This increases the price in the resale market.

Due-diligence

Whatever be the case, whenever you buy a property in the resale market or from the builder directly, one should always do his side of due diligence. One should verify the title records and ensuring that the property specifications confirm to the buyers.

Also when buying a resale property, one should always look for builder-buyer agreement and the payment receipt of the seller for the installment paid against the house. In addition, one should always look at the society bye-laws which all residents of the society are expected to follow. If you are uncomfortable with these bye-laws, it makes more sense to look for other properties.    

New guidelines for Revenue Recognition in Real Estate Companies

Real Estate companies follow “Percentage of Completion Method” of accounting. According to this method, revenue from sale of properties is recognized in the statement of profit and loss in proportion to the actual cost incurred as against the total estimated cost of projects under execution with the Company on transfer of significant risk and rewards to the buyer. If the actual project cost incurred is less than 20% of the total estimated project cost, no income is recognized in respect of that project in the relevant period. This is good, as the companies cannot inflate their profit and loss just on the basis of revenues collected during pre-launch. Companies are required to incur atleast 20% of total project cost estimated.

But determination of revenues under the percentage of completion method necessarily involves making estimates, some of which are of a technical nature, concerning, where relevant, the percentages of completion, costs to completion, the expected revenues from the project or activity and the foreseeable losses to completion. Estimates of project income, as well as project costs, are reviewed periodically. The effect of changes, if any, to estimates is recognized in the financial statements for the period in which such changes are determined. Losses, if any, are fully provided for immediately. Now the drawback of this method is that it involves inherent risk of relying upon estimates. The very fact that no rules exist to compute the project cost as well as for recording the revenues at different stages gives builders an undue advantage in their accounting system. 

But the best part is that new guidance have been issued prescribing new conditions for revenue recognition.

Companies should have all critical approvals that are needed to commence a project.

Company should incur 25% of construction and development (excluding land cost, cost of development rights and rehabilitation costs) to be incurred. The process still involves estimation leading to ambiguity. This will also result in deferral of revenue recognition for projects launched in FY13, as projects launched in that year will be reported in FY14 as it usually takes 12-15 months to achieve 25% of construction and development costs.

Companies should have sold at least 25% of saleable area. Again, it doesn’t make sense when let say the project is a 100 acre project or it is a 1 acre project. The PNL statement will get inflated the year a company sells 25% in a 100 acre project, which might take 1.5 to 2 years.

Collection of 10% or more at the reporting date, at the individual contract level.   

Still, these conditions will do away with some ambiguities and bring some uniformity across all real estate companies. It will be easier to compare financial statements of these companies now. 

Which city to invest in Real Estate market?

I concluded in my last blog NRI investors benefit from Rupee depreciation on a note that it’s a real challenge to identify the right property to invest. I am a proponent of end user more than an investor in physical real estate market. Still, even the end user dreams that his money gets multiplied wherever it is parked, be it in form of stocks or an apartment. So, the question is where to invest. Which market will give higher capital gains and rental value as compared to other markets in India? Which city will give a steady return in real estate market? And why? 

Well as per numbers or otherwise, we have seen in my last blog that Mumbai has favored the best in terms of capital gains of about 66% between during 2Q09-1Q13. Gurgaon has shown a return of 55%, whereas Bangalore has shown a gain of a little less than 50%.

I personally feel that Bangalore is well positioned to benefit in the real estate market. South India constitutes 20% of country’s population, and 22% of GDP. 45% of country’s office space comprising of 140 mn sq ft. lies here. The Indian Real Estate Transparency Index 2011 ranks Karnataka 6^th in terms of sectoral transparency (Source: Jones Long LaSalle). Bangalore stands well in place to benefit from this. There are several other reasons that act as demand drivers for Bangalore Real Estate.

       

      Real Demand: Bangalore is a stable organic market as 70% of its real estate demand is driven by end users, resulting in relative price stability which is unlike Delhi or Mumbai where investors overpower the end users.

   

    Employment Scenario: Bangalore is driven by middle-class, job-oriented families and immigrant salaried employees in the IT sector. Job scenario strengthened, evident from strong office absorption.

     Affordability: The residential real estate prices in the city grew steadily from their peak 2008 levels when compared with significant growth in NCR and Mumbai. Mid-segment housing prices in Bangalore were up by 4.1% while the high segment was 6.3% away from 2008 peak whereas NCR mid-segment was 29.1%, NCR high segment 27.1%, Mumbai mid segment 12% and Mumbai high-segment was 1.3% above their 2008 peaks.

     Financial City: The state-run IFCI Infrastructure Development Ltd. Plans to develop India’s first financial city at the Hardware park (30 km from Bangalore) across 50 acres in 3 years.

     Urbanization: According to United Nations, 40% of India’s population will be living in the urban areas by 2030, which is likely to strengthen urban residential demand.

     Tourism: The direct contribution of the travel and tourism sector to GDP is expected to increase from 1.9% (Rs. 1,689.8 bn) in 2011 to 7.7% (Rs. 3,805.2 bn) in 2022. The tourist arrival in India is expected to grow 3.5% to 65 lakh in 2012 and by 5.2% per annum to 112.76 lakhs in 2022 (Source: World Travel and Tourism Council). In the next five years in India, an additional 150,000 hotel rooms will be built to accommodate tourists (Source: CARE).

       Metro railways: The Union Budget 2012-13 allocated Rs. 9000 mn to Bangalore’s metro rail projects, which is likely to boost real estate demand.